How to Manage Post Retirement Income flow – Bucketing strategy

Money management during post-retirement years can be tricky. Those retiring at 60 may have another 25-30 years to live and a wrong asset allocation could lead to a situation where they outlive their savings, with no regular salary income to make up for the shortfall. Worse, retirees can fall prey to mis-selling, as was the recent case with a 64-year-old gentleman who was reportedly missold a Ulip that returned Rs 248 in five years on an initial investment of Rs 50,000.

This is where a distribution strategy – applied when the money required is scattered over more than a year – can work. Let us take an example to understand this. Fifty-eight year old Suresh Rao will be retiring this year and expects to receive Rs 30 lakh in retirement benefits, comprising Employees Provident Fund, General Provident Fund, gratuityand leave encashment. He will also get a regular monthly pension of Rs 15,000. His personal investment portfolio includes some fixed deposits, endowment LIC policies and debt mutual funds. He is a conservative investor and does not have any exposure to equity.

His post-retirement monthly expenses would be around Rs 25,000, for which the monthly pension amount will not suffice. Rao wants advice on the best way to invest his retirement corpus to supplement his pension income. He is also looking for an investment strategy that can take care of rising inflation and any other uncertain expenses that may arise in the future.

One option Rao has is to park his entire corpus in safe investment instruments like bank fixed deposits. However, FDs will not be able to beat inflation and are not tax efficient as the interest will be added to the income to be taxed in line with the individual slab rate. The other option is to park the money in debt mutual funds. This is a better option than bank FDs but may be a bit volatile in the short term. Also, debt MFs are taxed exactly like bank fixed deposits if the money is kept for less than three years.

Rao, therefore, needs to devise a strategy with an optimum mix of equity and debt. The best strategy that will work for him is ‘Bucketing’, wherein the total investment amount is divided into different buckets. Each bucket has a different objective and different investment products are assigned to each of these buckets. This strategy can be customised and applied on all retirement portfolios.

The first bucket is to manage the immediate needs of the investor. Since there’s no room for volatile products here, bank FDs or post office schemes come into this bucket. Income from this bucket will create a basic pension-like income or supplement the pension income, as in Rao’s case. Rao requires Rs 10,000 per month in addition to his pension amount. He can opt for a bank FD with a monthly interest payout to fund his requirement. At an FD rate of 8 per cent, he can invest Rs 15 lakh to earn Rs 1.2 lakh per annum, or Rs 10,000 per month. The duration of the FD could be three years.

There would be a need for a separate bucket for emergency needs. Ten per cent of one’s retirement funds could be parked in a safe and liquid instrument for this purpose. Rao is already earning an income of Rs 25,000 per month or Rs 3 lakh annually. His tax slab permits another Rs 1 lakh of taxable income, so he can comfortably park Rs 12.5 lakh in another bank fixed deposit and save the annual interest (of Rs 1 lakh) into any product under section 80C. This way his total taxable income in the form of bank interest and monthly pension will become tax free and the necessary liquidity will remain intact.

Bucket 2 is meant to refill the bucket 1 whenever required or it can supplement the monthly income in a more tax-efficient manner. In this bucket, one should use instruments like medium-term debt or debt-oriented hybrid mutual funds like monthly income plans or conservative asset allocation funds. When the monthly payment has to be increased, one can make use of the systematic withdrawal plan (SWP). SWP doesn’t lead to withdrawal of all units in one go, so the tax liability would not be much. If the monthly requirement of funds is not there, as in the case of Rao, one can keep the money in the growth option. If the SWP starts after three years of holding fund units, tax liability on capital gains booked will fall further.

Bucket 3 is meant to provide the necessary growth impetus to the complete portfolio. In the first two buckets, investments are done keeping in mind safety and tax efficiency. In bucket 3, investments will take into consideration inflation as well as tax efficiency. In this bucket, allocation will be made into equity funds or equity-oriented hybrid funds. Equities are volatile in the short-term but this should not bother the investor, as his short- and medium-term requirements are being taken care of by the first two buckets. Besides, the investment horizon for this bucket will be more than eight years. Any dividend income from bucket 3 can be used to fund bucket 1. Also, capital gains generated and booked can be used to fund bucket2.

There’s no thumb rule to divide the money into different buckets but generally 40 per cent in Bucket 1, 10 per cent in an emergency bucket, 30 per cent in Bucket 2 and 20 per cent in Bucket 3 will do the trick. The actual strategy may vary on a case to case basis. Even the duration for each bucket will vary depending on inflation and income needs.

He’s MBA ( Finance) gold medalist, a CERTIFIED FINANCIAL PLANNER and SEBI Registered Investment adviser. An ex banker , having a decade long experience in financial services industry he manages clients across the globe. He is a regular contributor to various leading Media and publication houses. He keeps on writing for Moneycontrol, Dainik bhaskar, Business standard etc. He also delivers training on Various personal finance topics to various corporate houses. You may get in touch with him at [email protected]

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Manikaran Singal is the founder and Chief financial planner at Good Moneying Financial Solutions. He is a CERTIFIED FINANCIAL PLANNER CM and SEBI registered Investment adviser (Regd no. INA 100001620). He’s having more than 12 years of experience in financial services space. More...